News feeds are stuffed full of reports and opinions about President Trump’s tariff increases on Mexico, Canada, China, and the EU. Then the add-on story is about the tax cut legislation—extending President Trump’s tax cuts to the coming years.
The media is spinning the story as a political hot potato: can tariff increases make up for the future revenue losses from extending the income tax reductions from President Trump’s first term?
This is a false scenario, and a dangerous one. It puts our standard of living at a critical crossroads. Here are the missing road signs.
Let us take a brief review of the economic and fiscal ramifications of both components facing us. Not extending the tax cuts means in effect a tax increase moving forward and a big economic uncertainty right now. Extending the tax cuts or cutting tax rates in general does a multitude of things to the economy, all of them good.
A reduction in the tax rate on income or the expansion of loopholes to avoid taxes is a powerful elixir for economic health. In either case, producers get to keep more of their earnings and get to use their income to satisfy their most urgent needs and desires. This increases individual satisfaction and the family’s standard of living. Because it is a general rule change, the positive effect is pervasive, so people can pay their bills, expand their consumption and savings, and can rightly think more positively about their future.
The greater after-tax return to labor means that more people will want to work, but employers don’t have to pay more to employees. Of course, as consumption increases some employers will perceive a benefit in hiring more workers and investing more in their companies. Banks will be more likely to grant loans on favorable terms. Those investments in plants and equipment mean greater efficiency, productivity, and higher wages. It also means more wealth and profits, a higher tax base, less government spending on the needy, and greater social investments by the rich.
Of course, even regular listeners of the Minor Issues podcast might be jaded about such a description, but that is because the government and the Fed have been siphoning off all these individual and social gains in our economy through increased government spending, deficit spending, and money printing.
To see the economics more clearly at the micro level, let us take a look at abolishing taxes on “tip” income. Such a move means more after-tax income for employees who labor to serve their customers in return for tips. They would be better off; more people would be willing to work in those types of jobs, and tip-related businesses would be more likely to survive and expand. It would create new businesses and jobs based on this model and some existing businesses might convert to the tip-based model to survive, expand, or reinvent themselves.
But in isolation, tax cuts cause the economy, per capita income, and wage rates to increase. The overall size of the economic pie gets larger over time, even if the population stays the same.
On the gold standard, initially the size of government would shrink as a result of the tax cuts. That is how it works today with state governments. But today at the federal level, we just hand the bill to the next generation and keep on spending and diluting the beneficial effects of the fiscal elixir.
So, a Congressional failure to cut government programs, serving special interests instead of the general good, and upholding a duty to balance the government budget and simply running bigger deficits sacrifices a further huge opportunity to reinvigorate the economy and increase the standard of living.
The Other Side of the Coin
Today, tariff revenues could never replace the fiscal power of the income taxes, could never balance the budget, and—in all likelihood—could not come close to offsetting the extension of the tax cuts.
In fact, tariffs actually have a poisonous effect on fiscal conditions. This is especially true if tariff policy expands globally or if it results in retaliatory moves by other countries. I recently recorded an episode of the Unanimity Podcast on the most important misconceptions about tariffs: Why Smart People Are Rightly Confused About Tariffs (1/4/2025).
As a poison, tariffs raise prices, reduce consumption by both consumers of goods and producers purchasing inputs for production. The higher prices cause reactions, such as people buying alternatives of less desirable goods and spending our money in less desirable ways. It also means people produce more protected goods for which they do not have a comparative advantage. That means hiring more people to produce things less efficiently and overall less production of goods and economic value.
Tariffs cause both a loss of efficiency and a decrease in the standard of living. Economists call this a double deadweight loss to society. While these losses might seem obscure and fleeting, I would say this is the primary reason economists of all ideological stripes are universally against tariffs and protectionism.
Based on one estimate of a fully-implemented global trade war, worldwide production of goods and services would fall by 2 percent per year and annual price inflation would increase by over 4 percent from current projected levels.
The poisonous effects of tariffs get worse, not better over time. For one thing, as people adjust to the tariffs, we get more inefficiency introduced into the economy and less satisfaction from our wages. Because consumers and producers adjust to tariffs over time, people buy fewer and fewer imports and produce more protected goods domestically. As tariff revenues necessarily fall over time, this means there is more political incentive to raise rates, especially supported by those working in artificially-protected jobs.
People also resort to more and more smuggling protected goods or simply finding loopholes and bribes in the government’s red tape to get more goods across the border tariff free. It is ironic that a President obsessed with the security of our border would unleash a massive smuggling operation upon those same borders!
In other words, the expected isolated impact of tariffs on the economy—viewed from a static perspective—is that the economy or economic pie gets smaller and smaller over time. The people in Washington, DC and the opinion class can afford to view the tax cuts and tariffs as bargaining chips, but we must view them both in the right economic light. Tax and spending cuts are the road to prosperity and tariffs are the road to ruin, and potentially war.
